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McGraw-Hill/Irwin
1-2
Basic Definitions
A cost is incurred when a firm uses a resource for
some purpose
The use of valuable resources, in order to
achieve a stated purpose. In accounting, cost
is reported in monetary terms.
Costs are assembled into meaningful groups called
cost pools (e.g., by type of cost or source)
Any factor that has the effect of changing the level
of total cost is called a cost driver
A cost object is any product, service, customer,
activity, or organizational unit to which costs are
assigned for some management purpose
1-3
Service firms . . .
Provide a service that is
consumed when produced.
Retailers . . .
Buy finished goods.
Sell finished goods.
Have no inventories.
MegaLoMart
Manufacturers . . .
Buy raw materials.
Produce and sell finished goods.
1-4
Manufacturing Companies
The
The 33 major
major categories
categories of
of manufacturing
manufacturing
costs:
costs:
Direct
DirectMaterials
Materials
Raw
Rawmaterials,
materials,
components,
components,and
and
other
otherparts
partsthat
that
can
canbe
betraced
tracedto
toaa
specific
specificproduct.
product.
Direct
DirectLabor
Labor
Payments
Paymentsand
and
benefits
benefitsfor
forthose
those
employees
employeeswho
who
convert
convertdirect
direct
materials
materialsinto
into
finished
finishedproduct.
product.
Manufacturing
Manufacturing
Overhead
Overhead
Indirect
Indirectmaterial
material
Indirect
Indirectlabor
labor
Other
Otheroverhead
overhead
1-5
Manufacturing Companies
Prime
Prime Costs
Costs include:
include:
Direct
DirectMaterials
Materials
Direct
DirectLabor
Labor
Manufacturing
Manufacturing
Overhead
Overhead
1-6
Manufacturing Companies
Conversion
Conversion Costs
Costs include:
include:
Direct
DirectMaterials
Materials
Direct
DirectLabor
Labor
Manufacturing
Manufacturing
Overhead
Overhead
1-7
Manufacturing Costs
Direct
Direct
Materials
Materials
Direct
Direct
Labor
Labor
The Product
Manufacturing
Manufacturing
Overhead
Overhead
1-8
Direct Materials
Raw materials that become an integral part of the
product and that can be conveniently traced
directly to it.
Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
1-9
Direct Labor
Those labor costs that can be easily
traced to individual units of product.
Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
1-10
Manufacturing Overhead
Manufacturing costs cannot be traced directly to
specific units produced.
Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor
1-11
Classifications of
Nonmanufacturing Costs
Selling Costs
Administrative
Costs
All executive,
organizational, and
clerical costs.
1-12
Learning Objective
Distinguish between
product costs and period
costs and give examples
of each.
1-13
Inventory
Sale
Balance
Sheet
Income
Statement
Income
Statement
1-14
Quick Check
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company? (There may be
more than one correct answer.)
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
1-15
MegaLoMart
Manufacturers . . .
Purchases raw
materials from
suppliers.
Produce and sell
finished goods to
customers.
1-16
Balance Sheet
Merchandiser
Current Assets
Cash
Receivables
Prepaid Expenses
Merchandise Inventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
Inventories:
1. Raw Materials
2. Work in Process
3. Finished Goods
1-17
Balance Sheet
Merchandiser
Current Assets
Cash
Receivables
Prepaid Expenses
Merchandise
Inventory
Partially complete
products some
material, labor, or
overhead has been
added.
Manufacturer
Current Assets
Cash
Receivables
Materials waiting to
Prepaid
be processed.
Expenses
Inventories:
1. Raw Materials
2. Work in Process
3. Finished Goods
Completed products
awaiting sale.
1-18
Learning Objective
Prepare an income
statement including
calculation of the cost of
goods sold.
1-19
$ 14,200
234,150
$ 248,350
(12,100)
$ 236,250
1-20
Inventory Flows
Beginning
Beginning
balance
balance
Additions
Additions
to
to inventory
inventory
Ending
Ending
balance
balance
Withdrawals
Withdrawals
from
from
inventory
inventory
1-21
Quick Check
If your inventory balance at the beginning of
the month was $1,000, you bought $100
during the month, and sold $300 during the
month, what would be the balance at the end
of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
1-22
Learning Objective
1-23
1-24
+
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Work
As
items
are
removed
from
AsCosts
items are removed
from
In Process
raw
raw materials
materials inventory
inventory and
and
placed
placed into
into the
the production
production
process,
process, they
they are
are called
called direct
direct
materials.
materials.
1-25
+
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
Work
Conversion
Conversion
In Process
costs
costsare
arecosts
costs
incurred
incurredto
to
convert
convert the
the
direct
directmaterials
materials
into
into aafinished
finished
product.
product.
As
Asitems
itemsare
areremoved
removedfrom
fromraw
raw
materials
materialsinventory
inventoryand
andplaced
placedinto
into
the
theproduction
production process,
process, they
theyare
are
called
calleddirect
direct materials.
materials.
1-26
+
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Costs
Work
In Process
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period
Ending work in
All
manufacturing
incurred
All manufacturing costs
costs
incurred
process
inventory
during
added
to
=are
Cost
of goods
during the
theperiod
period are
added
tothe
the
manufactured.
beginning balance of
work in
1-27
Manufacturing
Costs
Beginning raw
Direct materials
materials inventory
+ Direct labor
+ Raw materials
+ Mfg. overhead
purchased
= Total manufacturing
= Raw materials
costs
available for use
in production
Ending raw materials
inventory
Costs
associated
with
Costs
associated
with the
thegoods
goodsthat
that
= Raw materials
used
are
completed
arein
completed
duringthe
the period
period are
are
production during
transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.
+
=
Work
In Process
Beginning work in
process inventory
Total manufacturing
costs
Total work in
process for the
period
Ending work in
process inventory
Cost of goods
manufactured.
1-28
1-29
Balance Sheet
Inventories
Material Purchases
Raw Materials
Direct Labor
Work in
Process
Manufacturing
Overhead
Selling and
Administrative
Finished
Goods
Period Costs
Income
Statement
Expenses
Cost of
Goods
Sold
Selling and
Administrative
1-30
Quick Check
Beginning raw materials inventory was
$32,000. During the month, $276,000 of raw
material was purchased. A count at the end of
the month revealed that $28,000 of raw
material was still present. What is the cost of
direct material used?
A.
$276,000
B.
$272,000
C.
$280,000
D.
$ 2,000
1-31
Quick Check
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A.
$555,000
B.
$835,000
C.
$655,000
D.
Cannot be determined.
1-32
Quick Check
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A.
$1,160,000
B.
$ 910,000
C.
$ 760,000
D.
Cannot be determined.
1-33
Quick Check
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. The ending finished
goods inventory was $150,000. What was the
cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
1-34
Learning Objective
Understand the
differences between
variable costs and fixed
costs.
1-35
Total
Total variable
variable costs
costs change
change
when
when activity
activity changes.
changes.
Total
Total fixed
fixed costs
costs remain
remain
unchanged
unchanged when
when activity
activity
changes.
changes.
1-36
Variable Cost
1-37
5-38
Cost
Volume
5-39
Step-Variable Costs
Cost
A
A resource
resource that
that is
is obtainable
obtainable only
only in
in large
large chunks
chunks
(such
(such as
as maintenance
maintenance workers)
workers) and
and whose
whose costs
costs
increase
increase or
or decrease
decrease only
only in
in response
response to
to fairly
fairly
wide
wide changes
changes in
in activity.
activity.
Volume
5-40
Step-Variable Costs
Cost
Small
Small changes
changes in
in the
the level
level of
of production
production are
are not
not
likely
likely to
to have
have any
any effect
effect on
on the
the number
number of
of
maintenance
maintenance workers
workers employed.
employed.
Volume
5-41
Step-Variable Costs
Cost
Volume
5-42
Total Cost
A
A straight
straight line
line
Economists
closely
closely
Curvilinear Cost approximates
approximates aa
Function
curvilinear
curvilinear
Relevant
Range
variable
variable cost
cost
line
line within
within the
the
relevant
relevant range.
range.
Accountants Straight-Line
Approximation (constant
unit variable cost)
Activity
1-43
Fixed Cost
Your monthly contract fee for your cell phone is fixed for
the number of monthly minutes in your contract. The
monthly contract fee does not change based on the
number of calls you make.
1-44
5-45
Discretionary
Discretionary
Long-term,
Long-term, cannot
cannot be
be
significantly
significantly reduced
reduced
in
in the
the short-term.
short-term.
May
May be
be altered
altered in
in the
the
short-term
short-term by
by current
current
managerial
managerial decisions
decisions
Examples
Examples
Examples
Examples
Depreciation
Depreciation on
on
Buildings
Buildings and
and
Equipment
Equipment and
and
Real
Real Estate
Estate Taxes
Taxes
Advertising
Advertising and
and
Research
Research and
and
Development
Development
1-46
In Total
Per Unit
Variable
Fixed
1-47
Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be
more than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
5-48
Rent Cost in
Thousands of Dollars
60
Range
30
0
Total
Total cost
cost doesnt
doesnt
change
change for
for aa wide
wide
range
range of
of activity,
activity, and
and
then
then jumps
jumps to
to aa new
new
higher
higher cost
cost for
for the
the
next
next higher
higher range
range of
of
activity.
activity.
1,000
2,000
3,000
Rented Area (Square Feet)
5-49
5-50
Step-variable costs
can be adjusted
more quickly and . . .
The width of the
activity steps is
much wider for the
fixed cost.
5-51
Quick Check
Which
Which of
of the
the following
following statements
statements about
about cost
cost
behavior
behavior are
are true?
true?
a.
a. Fixed
Fixed costs
costs per
per unit
unit vary
vary with
with the
the level
level of
of
activity.
activity.
b.
b. Variable
Variable costs
costs per
per unit
unit are
are constant
constant within
within the
the
relevant
relevant range.
range.
c.
c. Total
Total fixed
fixed costs
costs are
are constant
constant within
within the
the
relevant
relevant range.
range.
d.
d. Total
Total variable
variable costs
costs are
are constant
constant within
within the
the
relevant
relevant range.
range.
5-52
Mixed Costs
A mixed cost has both fixed and variable
components. Consider your utility costs.
Total Utility Cost
ta
o
T
xe
i
lm
s
o
dc
t
Variable
Cost per KW
Fixed Monthly
Utility Charge
5-53
Mixed Costs
ta
o
T
xe
i
lm
s
o
dc
t
Variable
Cost per KW
Fixed Monthly
Utility Charge
5-54
Y = a + bX
Y = $40 + ($0.03 2,000)
Y = $100
5-55
Each
Each account
account is
is classified
classified as
as either
either
variable
variable or
or fixed
fixed based
based on
on the
the analysts
analysts
knowledge
knowledge of
of how
how the
the account
account behaves.
behaves.
Engineering
Engineering Approach
Approach
Cost
Cost estimates
estimates are
are based
based on
on an
an
evaluation
evaluation of
of production
production methods,
methods,
and
and material,
material, labor
labor and
and overhead
overhead
requirements.
requirements.
5-56
Learning Objective
5-57
Maintenance Cost
1,000s of Dollars
Y
20
* *
* *
10
* ** *
**
Patient-days in 1,000s
5-58
Maintenance Cost
1,000s of Dollars
Y
20
* *
* *
10
* ** *
**
Patient-days in 1,000s
Draw
Draw aa line
line
through
through the
the
data
data points
points
with
with about
about
an
an equal
equal
number
number of
of
points
points above
above
and
and below
below
the
the line.
line.
5-59
Maintenance Cost
1,000s of Dollars
* ** *
**
* *
* *
10
Patient-days in 1,000s
Patient days = 800
Use
Use one
one
data
data point
point
to
to estimate
estimate
the
the total
total
level
level of
of
activity
activity
and
and the
the
total
total cost.
cost.
5-60
$1,000
800
Y = $10,000 + $1.25X
Total maintenance cost
5-61
Learning Objective 3
5-62
5-63
5-64
5-65
Y = $3,400 + $8.00X
5-66
Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the variable
variable portion
portion of
of sales
sales
salaries
salaries and
and commission?
commission?
a.
a. $0.08
$0.08 per
per unit
unit
b.
b. $0.10
$0.10 per
per unit
unit
c.
c. $0.12
$0.12 per
per unit
unit
d.
d. $0.125
$0.125 per
per unit
unit
5-67
Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
5-68
5-69
5-70
1-71
Learning Objective
Understand the
differences between
direct and indirect costs.
1-72
Indirect costs
Examples: Direct
material and direct labor
Example: Manufacturing
overhead
1-73
Learning Objective
Understand cost
classifications used in making
decisions: differential costs,
opportunity costs, and sunk
costs.
1-74
1-75
1-76
Opportunity Costs
The potential benefit that is given up
when one alternative is selected
over another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.
1-77
Sunk Costs
Cannot be changed by any decision. They
are not differential costs and should be
ignored when making decisions.
Example: You bought an automobile that cost
$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.
1-78
Quick Check
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.
1-79
Quick Check
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the annual cost of licensing your car relevant
in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
1-80
Quick Check
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
1-81
Predicting
Cost
Behavior
Assigning
Costs to Cost
Objects
Decision
Making
1-82
End of Chapter 2